Incentives for Informal
Contract Enforcement:
The Case of Russian
Public Procurement
Svetlana Pivovarova
XI HSE International Academic Conference
on Economic and Social Development Problems, April 8, 2010
International practice
• Free choice (limited):
– who you chose from: prequalification;
– how you chose: procedure.
• Reputation:
– ability to use previous experience.
• Warrants
• Legalistic enforcement
Russian public procurement law
• Free choice facilitates corruption
• Excessive use of reputation hinders
competition
• Limited choice + federal reputational
database
Problems: formal enforcement
• Lack of prequalification
• Prevailing procedure: first-price auction
– Hard to access quality
• “Official List of Dishonest Suppliers”
– The procurer CAN (but is not obliged to) use the list
• Judicial system: imperfect and slow
Hints from the survey
• 80% - receiving goods with “bad” quality
that meet official requirements is a serious
problem
• Direct negotiation vs. court – 46% vs. 9%
• Fears:
– “One-day” firms
– “Administratively powerful” firms
– Under-qualified firms
– Subcontracting to unknown supplier
Modeling the imperfect court
• Punishment is less than the damage
(Doni, 2006)
• Only a certain proportion of breached
contracts is enforced (Anderson and
Young, 2002)
Modeling the imperfect court
• Punishment is exogenous:
– The loosing side pays a fine A in favor of the
winning side
• The proportion   1 of breached contracts
is enforced
• The court is costly:
– Fixed legislative costs for the procurer and
G
S
L
L
the supplier, and
Model setup: agents
• The procurer is sensitive to quality:
– Utility function u (Q)  0 , Q  Q ,
u ()  0, u ()  0
• Suppliers are different in production costs
and legislative costs
– Production costs: cQ
Model setup: rules of the game
• Single indivisible object with minimum
acceptable quality Q
• First price sealed bid auction
• The supplier may breach the contract by
supplying Q  Q
• The procurer may apply the case to court
Contracting stage results
• The suppliers are characterized by
P1 ( L, c) and P2 ( L, c)
 
 
• If P[ P1, P2 ] the supplier always
produces zero quality
– High production costs with
– Low legislative costs
Contracting stage results
• Extreme cases:
1 LS
–  
- dumping the price to zero may
2 2A
be profitable for the supplier;
LG 1
 - the contract may be breached but
– 
2A 2
the procurer wouldn’t go to court
Auction stage results
• If production costs for all suppliers are
high – the legalistically efficient wins and
produces zero
• Eliminating bids lower than E( P1 ( L, c))
is profitable for the procurer
Future research
• Adding costly use of reputation and\or
elimination of low bids
• Further analysis of regional and survey
data